For over 30 years I have been tilting mirrors to reflect the economy in a different perspective from what the consensus anticipates and markets are pricing – this includes nearly 20 years of using my analysis to manage global fixed-income portfolios. My career includes econometric modeling at Data Resources Inc., creating derivatives market strategies at Salomon Brothers, managing fixed-income portfolios at OFFITBANK, and being global head of fixed-income at Lazard Asset Management. As Chief Economist of ITG IR I am in the great and unique position of being able to combine my experience with extraordinary real time information from a unique set of “big data.” To help get my career started, I earned a BA in Economics from New York University and an MA in Economics from Columbia University.

FOMC Looking For The Exit, Any Which Way They Can

Reading the July FOMC minutes and the description of the current economy, it is hard to square what was being said with a zero interest rate policy. Truth is, they really can’t either. With that reality setting in among the various heads of the Fed’s realm, the FOMC wants out of its policy box and to start normalizing rates as quickly as possible. Wanting to have their cake and eat it too, they want to do this without disrupting markets or general economic activity. This means lots of dovish talk, beginning with Yellen tomorrow morning in Jackson Hole, to soothe markets and keep forward curves from getting too far in front of policy.

Whether they are right in their assessment of growth and the ability of the economy to handle the Fed leading interest rates higher, even from zero, is another matter. The slowdown in housing beginning with last year’s taper-talk is indicative of the economy’s sustained sensitivity to higher interest rates. The ten-year has had to give back about 75% of the increase in yields before builders became more confident again – despite y/y gains in income and employment.

Housing remains an important topic for the FOMC, along with employment and inflation potential. In their discussion about housing they seem to distinguish between a “housing recovery” and the rental market “providing support for multifamily construction.” It is as if a boom in multi-family is somehow a lesser recovery. If they are waiting for the pre-recession housing market to return, they are likely to be waiting for a long time.

As far as the labor market is concerned we get “ . . . labor market conditions had moved noticeably closer to those viewed as normal in the longer run. Participants differed, however, in their assessments of the remaining degree of labor market slack and how to measure it.” Fair enough. Further into their discussion we read “the elevated level of relatively low-paid part-time workers was holding down overall wage increases.” I gather from that there is still plenty of slack in the labor force, regardless of the higher quit and hire rates reported in the BLS JOLTs report.

The wage story feeds directly into inflation. The FOMC view is “Inflation firmed in recent months, and most participants anticipated that it would continue to move up toward the Committee’s 2 percent objective. Many of them expected that inflation was likely to rise gradually over the medium term, as resource slack diminished and inflation expectations remained stable.” The discussion appears to make no real distinction between rising prices and inflation. Without real increases in wages, there is no inflation. There are higher prices for staples such as rent that, in turn, reduce discretionary spending and thus hold down prices for the things people want rather than need.

Regardless of the differences among the FOMC participants about their read on employment and inflation, they “generally agreed that labor market conditions and inflation had moved closer to the Committee’s longer-run objectives in recent months, and most anticipated that progress toward those goals would continue. Moreover, many participants noted that if convergence toward the Committee’s objectives occurred more quickly than expected, it might become appropriate to begin removing monetary policy accommodation sooner than they currently anticipated.”

While the FOMC knows this is not the best of all possible worlds, they also know that staying at zero for much longer reduces options in the event the economy slows or has them behind the curve in the event the economy speeds up.

The market has the FOMC tightening in the second quarter. If the economy grows according to their plans, I would expect them to tighten by the March 18 meeting – there is no reason to wait until April or June.There is also a better than even chance they go at the end of January presuming a good holiday season and no disruptive winter weather. On Friday morning expect Yellen to give a dovish talk, but remember it is, in our view, all in the name of controlling markets until the FOMC finally moves.

Post Your Comment

Post Your Reply

Forbes writers have the ability to call out member comments they find particularly interesting. Called-out comments are highlighted across the Forbes network. You'll be notified if your comment is called out.